Chart of the week – A view on rates and risk, part 1


Chart of the Week – A view on rates and risk, part 1

Recently, we highlighted our thoughts on the US consumer’s impact on the domestic economic recovery as well as our view on inflation in relation to Consumer Price Index.

Our Fed forecast

We believe the Federal Reserve (Fed) will begin tapering its asset purchase program, currently at $120 billion per month, in January 2022 and complete tapering by the end of year. We expect the first interest rate hike of the cycle to occur in the second quarter of 2023. We think the risk to this forecast is for the Fed to act sooner, and think the market is currently underestimating how much the Fed will have to hike interest rates, once the rate hike cycle starts.

Impact on interest rates and risk assets

If the Fed is successful in generating inflation, we think this could bring about higher nominal gross domestic product (GDP) growth than the US economy experienced in the last cycle. This has potential implications for market interest rates and risk assets.

The steepness of the yield curve for US Treasury bonds (as measured by the difference between the yield on the 10-year bond and 2-year bond) usually peaks before the first Fed interest rate hike of a cycle as the market anticipates the Fed’s actions by pushing up yields at the short-end of the curve. While some may view this as a bearish signal, this typically happens early in the economic cycle. We would not become concerned about the slope of the yield curve unless it turns negative.

US policy rate and the yield curve

Chart source: Macrobond. Dates shown are January 1, 1990 to July 1, 2021.


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